Glass-Steagall vs. the Volcker Rule

For the second time in less than 80 years, the nation’s commercial banks are being told to stick to their knitting. Their knitting is taking deposits, handling checking accounts, lending money and managing the nation’s payment system. Twice now, they have ventured beyond these standard activities, gotten into trouble and almost brought down the financial system.

The solution in the 1930s, and once again now, is this: get out of the sideline businesses that caused so much trouble. Those sidelines were different in the 1930s than they are now. And while people talk of re-enacting Glass-Steagall Act — the solution that helped resolve the 1930s crisis — what President Obama proposed this week is a somewhat different animal, worthy of its own name.

The Banking Act of 1933 — forever known as the Glass-Steagall Act in recognition of its sponsors, Senator Carter Glass and Representative Henry B. Steagall — required banks to spin off or shut down their brokerage and investment operations.

These operations had lost huge sums in the 1929 stock market crash and in the early years of the Depression. The banks, for example, would underwrite corporate stock offerings, and if they had trouble selling the stock they would buy it with money drawn from depositors’ accounts, sometimes without a depositor’s knowledge.

Or as William Donaldson, a former chairman of the Securities and Exchange Commission, put it in an interview: “If they were underwriting a stock offering and had trouble getting rid of the stuff, they would buy it with people’s deposits.”

The restrictions imposed by Glass-Steagall kept bank deposits, and banks themselves, at a safe distance from the markets. But that distance gradually shrank, and in the heady, free-market days of the late 1990s, Glass-Steagall itself was formally revoked.

So commercial banks — the big ones, at least — returned to the Wall Street marketplace. This time they got into trouble by engaging in proprietary trading — that is, the buying and selling of securities for their own account, particularly subprime mortgages packaged as bonds. When that market crashed in 2008, the federal government bailed out the banks, and now the president is asking Congress to bar banks from proprietary trading.

The president is acting on a proposal that Paul Volcker, the former chairman of the Federal Reserve, has been pushing for months. It is sometimes referred to as “Glass-Steagall in spirit.” But the behavior involved and the proposed solution are different enough for the legislation to have its own nickname — and Obama himself has suggested one: “The Volcker Rule.”